Americans Are Buried In High-Interest Debt & Banks Have Become The New Company Store
Like the sharecroppers and coal miners of earlier days, many Americans now survive by borrowing instead of earning
By David Grace (www.DavidGraceAuthor.com)
Inventions That Have Fundamentally Changed Society
We can all name inventions that have fundamentally changed the world for the better, e.g. the steam engine and the transistor.
We could also list institutions, policies or technologies that have materially changed the world for the worse — slavery, prohibition, the tobacco-curing technology that allowed burning tobacco to carry nicotine across the blood-brain barrier, the invention of heroin and crack cocaine.
This column is about a societal innovation that has massively changed Americans’ lives in some ways for the better and in several ways for the worse:
The replacement of the store/finance-company consumer-credit system with the low-minimum-payment credit-card.
The Massive Increase In Working-Class Debt
In 2016 dollars, between 1963 and 2016 the switch from a store/finance-company consumer-credit system to a credit-card consumer-credit system has powered an approximately 650% increase in the amount of debt owed by the bottom 20% of households, up from about $1,700/household in 1963 to about $11,000/household in 2016.
Financing consumer purchases through low-minimum-payment credit cards has:
- Massively impoverished the American middle and working classes,
- Over the last fifty years powered at least a 400% increase in the indebtedness of the bottom 40% of American households
- Deterred saving
- Encouraged unnecessary spending
- Increased the cost of living for middle and working class households by tens of billions of dollars per year through high interest payments and fees, and
- Enabled the impoverishment of workers by hiding the pain of low wages through artificially low minimum monthly payments, substituting living by borrowing money rather than by earning money
How Consumer Purchases Were Financed Prior To 1970
In the 1950s if a middle-class or working-class family wanted to buy a car, a refrigerator, or a bedroom set they went to a car dealer, an appliance store or a furniture store, picked out what they wanted, and either paid cash that they had saved or they got a loan through the store.
Each new non-cash purchase was funded by a separate loan which was amortized over a relatively short period of time, maybe five years for a car or two or three years for furniture or appliances.
If the new bedroom set cost $900, the non-cash buyer would borrow the money from a finance company that serviced the store’s customers with a payment of perhaps $30/month for three years.
Suppose in 1965 a bus driver, welder, teacher, police officer, etc. went to the appliance store to buy one of the new Zenith color TVs for $500. The store manager would check his credit and perhaps discover that the buyer already had a loan with a finance company for his furniture, a loan with the bank for his car, and a monthly obligation either for his mortgage or to his landlord for his rent.
The appliance store’s cooperating finance company might then decide that the customer didn’t qualify for another loan to buy the TV.
This system of separate, sequential, relatively short term, fully amortized loans for each major purchase, each of which loans required a new credit approval, made it very difficult for the average middle-class or working-class family to amass a great deal more debt than they could handle.
In 1963 the average wealth of households in the bottom 20%, measured in 2016 dollars, was a negative $1,676, that is, the average bottom 20% household was about $1,700 in debt. In 2016 that same average household debt was over $11,000.
The Widespread Availability Of Consumer Credit Cards In The Late 1960s
In 1966 the Bank of America licensed the BankAmericard to other banks under the VISA system. In 1968 VISA cards were available in 42 states. In December 1966 MasterCharge was created. In 1979 it changed its name to MasterCard.
This late 1960s/early 1970s replacement of the store/finance-company consumer-credit system with a credit-card consumer-credit system has had massive, negative effects on American life.
Credit-Card Consumer Financing Is Different From Finance-Company Consumer Financing In Several Very Important Ways
No Credit Checks When Borrowing For Major New Purchases
Under the old, store/finance-company system, each major new purchase required the consumer to pass a new credit check. If the latest finance company was uneasy about the consumer’s ability to repay the requested new loan, the application was rejected, and consumer was prevented from taking on more debt than it appeared that he could handle.
Under the new, credit-card system, the consumer had to only pass one credit check at the time the card was initially issued. After that, the consumer could spend up to the card limit at any time without anyone ever checking to see if he could actually afford to pay for the purchases.
Much Lower Monthly Payments Tripled The Amount Of Debt A Consumer Could Incur
Under the old, store/finance-company system, payments were calculated so as to pay off the debt in 24 or 36 months, so a $900 loan at 12% interest would generate payments of around $29/month.
Under the new, credit-card system, minimum payments were between 1% and 3% of the total balance, so the minimum payment on a $900 debt could be as low as $9/month.
So, not only could the consumer run up additional debts he couldn’t pay off because there were no longer new credit checks reviewing his ability to pay for new purchases, but also the credit card’s lower monthly payments would support a much higher debt load.
Where a $29/month payment would service a $900 debt under the store/finance-company system that same $29/month payment would service a $2,900 dollar debt under the credit-card consumer finance system.
With the switch from store/finance-company consumer credit to credit-card consumer credit, the consumer was allowed to triple the amount of debt he could take on with no review as to whether or not he could afford to pay it back.
Higher Interest Rates Reduce The Consumer’s Disposable Income
In the 1950s and 1960s the store/finance-company interest rates were generally between 12% and 18%.
Today, the average credit-card interest rate for consumers with good credit is about 20% and for those with excellent credit about 13.5%, with the average rate being about 15%.
The credit-card consumer-financing system not only allows a consumer to take on several times more debt, it does so at higher interest rates which increase the consumer’s cost of living.
These higher rates on larger debts make that loan balance much more difficult and more expensive to ever pay off.
Banks Increase The Interest Rate After The Debt Was Incurred
If you bought a refrigerator, a TV or a sofa under the old store/finance-company system your interest rate of 12% was locked in for the entire two or three year term of the loan, but under the consumer credit-card system the interest rate on the loan can be increased at any time.
If the consumer is promised a 12% credit-card interest rate and runs up a $3,000 balance, the bank is free to increase that 12% rate to 29.9% on thirty days advance notice, which means that the balance that the consumer owes thirty days after the notice will bear interest at the new, 29.9% rate even though the purchases that generated that balance were made back when the agreed rate was 12%.
Banks Don’t Want The Debt To Ever Be Paid Off
Under the store/finance-company borrowing system the number-one goal for every lender was getting its loan paid off on time and in full.
The farther the consumer went into debt, the less new debt the consumer could incur because each new loan request was scrutinized by each new lender and the greater the consumer’s existing debt the less likely it was that the new lender would approve the requested new loan.
The credit-card financing system has turned this on its head.
Since interest rates of 20% or more were common, the issuing banks’ primary goal was not the prompt repayment of the principal amount of the debt, but rather the continuing accrual and payment of interest on the debt.
Unlike the finance company that wanted their debt paid off on time, the banks want their debts to continue earning interest forever.
The Minimum Monthly Payment Is Less Than The Monthly Interest Charge
At 20%, a balance of $10,000 would generate $2,000/year in interest. If the minimum payment was 1.5% the consumer would be paying the bank $150/month.
At the end of a year the bank would have received $1,800 toward an interest charge of $2,000 which means that in spite of making $1,800 in payments, by the end of the year the consumer’s debt would have increased to $10,200.
Under the credit-card consumer-finance system, it is in the bank’s interest for the consumer to have as big an debt as possible unpaid for as long as possible.
In fact, it is common for banks to monitor their cardholder’s transactions to determine when the consumer is in financial trouble and then to offer to raise the consumer’s credit limit, inviting them to go even deeper into debt, but at a higher interest rate.
The struggling consumer then charges even more purchases and drives his unpaid balance even higher while the bank raises the interest rate, simultaneously increasing both the number of dollars borrowed and also collecting more interest on each dollar borrowed.
Credit Cards Have Allowed Banks To Become Everyone’s New Company Store
In 1955 Tennessee Ernie Ford released his signature song “16 Tons” about an impoverished coal miner. The chorus ran:
16 tons and what do you get?Another day older and deeper in debt.Saint Peter don’t you call me ’cause I can’t go.I owe my soul to the company store.
The wages paid to coal miners and sharecroppers were, by design, too low for them live on. To survive they had to borrow — supplement their meager wages by buying what they needed on credit from the company store.
Once buried in debt to the company store, they were little better than mediaeval serfs. Imprisoned in perpetual debt to their employer, it was almost impossible for the workers to quit or strike for higher pay.
Under the credit-card consumer-finance system banks have become many Americans’ new Company Store.
Crushed by low wages and lured by minimum monthly payments too low to even cover the interest, millions of middle and working-class Americans have supplemented their earnings with borrowing and fallen into inescapable debt to the banks.
Instead of just the sharecropper or the coal miner being buried in debt to his employer’s company store, now tens of millions of working Americans are buried in debt to the new company store, their credit-card’s bank.
Low Credit-Card Minimum-Payment Charges Mask The Pain Of Low Wages
If you have a toothache or an infection, a broken limb or a festering wound the worst thing you can do is ignore the injury and just take a drug that dulls the pain.
Today’s credit-card consumer-finance system is the financial equivalent economic morphine that dulls the pain of low wages, excessive interest, and foolish spending.
Today’s credit-card consumer-finance system was designed to mask the pain from foolish spending, excessive borrowing, and insufficient wages in order to generate and perpetuate pervasive, massive high-interest debt and huge bank profits.
The low-minimum-payment credit-card consumer-finance system lures workers into supplementing inadequate wages with more borrowing rather than by demanding higher wages.
It encourages workers to buy unnecessary goods through low-minimum-payment borrowing instead of abstaining from purchasing things they don’t need and saving for the things that they do.
High-interest, low-minimum payments and easy credit deter people from delaying gratification and saving by enabling instant borrowing and immediate consuming.
Easy, High-Interest Credit Is The Economic Equivalent Of Heroin
High-interest, low-minimum payment, easy credit is a drug as addictive as heroin or crack cocaine. Like the stereotypical dealer who tells school children, “Here, just try it. The first one is free,” banks happily hand out credit cards to young adults with the same pitch, “Here, try it. It’s free.”
Unsophisticated people are lured into excessive spending with minimum monthly payments that are less than the monthly interest, guaranteeing that their debt will continue to grow.
And when the consumer bumps up against the credit limit, the bank often volunteers to do them a favor by raising that limit so they can go even further into debt, but, of course, at a higher interest rate.
Soon the borrower is hooked, thousands of dollars in debt, accruing interest at 20% or more per annum, with monthly payments that don’t even cover the interest.
Multiply that by a hundred million Americans and you begin to understand that banks are the financial equivalent of drug dealers except that instead of heroin or crack cocaine their product is easy, expensive, lifetime debt.
Fixing The Problems
The number-one factor driving excess and often unnecessary credit-card borrowing is the low minimum payment. The lower the minimum payment, the greater the amount of debt that the consumer can carry.
Increase The Minimum Payment To At Least High Enough To Cover Current Interest
The most direct way to fix this is by requiring banks to set a minimum monthly payment equal to one-month’s interest plus 1% of the balance.
If the balance owed is $12,000 and the interest rate is 15% then one-month’s interest is $150 + 1% of $12,000 or $120 = a $270 minimum monthly payment instead of a 1% minimum payment of $120.
This higher minimum payment:
- Guarantees that the payments will be sufficient to cover interest charges and reduce the principal by 12%/year,
- Reduces the total amount of debt the consumer can afford to service
- Makes the consumer acutely aware of the magnitude of the interest they are paying
Adding A Quarterly Card Limit
In addition to the overall card limit, set a limit on the amount the consumer can charge in any three month period of no more than 25% of the card limit.
For example, if the card limit was $10,000 then the consumer couldn’t charge more than $2,500 in any three month period.
This would prevent the consumer from going on a spending spree and would encourage card usage for the normal expenses of living and deter unnecessary purchases of big-ticket items.
If the consumer knows that the card will not cover the entire cost of a new appliance the consumer will have a greater incentive to save money to cover that excess cost and will be more careful about purchasing big-ticket items.
Prohibit Increasing The Interest On An Existing Balance
If the bank was required to treat all outstanding balances as loans at the interest rate in effect at the time of the purchase, the bank would be deterred from
- Bait-and-switch teaser interest rates followed by a rate increase once the consumer had incurred a large balance
- Granting more credit than the consumer will likely be able to repay
- Enticing consumers to accrue high balances
- Raising interest rates because the consumer’s response to a rate increase that only applies to new purchases will be to replace that card with a new, lower interest one for new purchases.
When I grew up in the 1950s my parents told me: “If you can’t pay cash, you can’t afford it.”
Living by that philosophy not only forced people to think twice before they bought something, it encouraged them to earn more and save more.
When people can buy anything they want without questioning whether or not they can afford it or what its real cost will be, they buy things they don’t need and incur costs they can’t afford.
Eventually, they end up the bank’s prisoner, mired in a debt they can never repay for stuff they didn’t really need.
They get used to living on easy credit to supplement their low wages instead of fighting harder for a higher salary. They become as much a prisoner of their bank as a heroin addict is a slave to his drug dealer.
The Credit Card System Is Designed To Make Banks Rich & Consumers Poor
There is a reason the credit card system is run this way, with easy credit, low monthly payments and huge interest rates. Because it creates a captive population which pays the banks tens of billions of dollars per year in interest.
It was designed to make the banks HUGE amounts of money. It continues to run this way because the banks, the financial industry, and the American economy are founded on the principle of massive, constant consumption that generates huge profits for banks.
The businesses that control this country will not willingly allow anything that materially threatens that policy of ever-increasing consumption and massive financial-industry profits no matter how much those policies keep at least half of American households without savings, massively in debt, and underpaid.
Think about that the next time you vote for some politician who says that his primary goal is keeping businesses free to do whatever they want without any pesky government regulations.
–David Grace (www.DavidGraceAuthor.com)
